Considering the VAT effect of dividends

"A dividend in specie generally constitutes a
distribution made to the beneficial owner of a share in any form other than in
cash”

Considering the VAT consequences
for a VAT vendor who declares dividends to its shareholders, may at first
appear to be simple. However, the VAT treatment seems to become more complex as
soon as one tries to justify it in terms of the provisions contained within the
Value-Added Tax Act (89 of 1991) ("VAT Act”). The purpose of this article is to
take a closer look at the VAT consequences where a VAT vendor declares
dividends (either in cash or in specie)
to the beneficial owners of its shares and to justify it in terms of the provisions
of the VAT Act.

In general, section 7(1)(a) of the VAT Act determines that output
VAT should be levied where a vendor makes a supply of goods or services in the
course or furtherance of its enterprise. The terms "supply”, "goods” and "services”
referred to within section 7(1)(a)
are all defined in section 1 of the VAT Act. It is therefore clear that where
there is no "supply” of "goods” or "services”, no VAT output needs to be
accounted for. However, section 7(1)(a)
is not the only provision in the VAT Act that requires output VAT to be levied.
With the distribution of a dividend in
specie it needs to be considered
whether a possible change in use adjustment in terms of section 18(1) of the
VAT Act is required. It also needs to be considered how the VAT treatment will
be affected, if at all, where the holder of shares receiving the dividend in specie is a connected person in relation to the
vendor who declares it.

Dividends
in cash

A "supply” is defined in section 1
of the VAT Act and includes "...all forms
of supply, whether voluntary, compulsory or by operation of law...”. Thus,
a vendor’s decision to declare a cash dividend to its shareholders will qualify
as a supply and will in effect constitute the supply of money. Due to the fact
that "money” is specifically excluded from both the definitions of "goods” and
"services” as defined in section 1 of the VAT Act, no VAT effect will arise on
the distribution of a cash dividend as there is neither a supply of goods nor
services.

Dividends
in specie

A dividend in specie generally constitutes a distribution made to the
beneficial owner of a share in any form other than in cash (such as the
distribution of trading stock or a capital asset). It therefore seems as if
section 7(1)(a) could now take effect
as it is no longer "money” which is distributed. It still needs to be
determined whether the distribution of a dividend in specie does in fact
constitute the supply of "goods” or "services” for VAT purposes. Neither the definitions
of "goods” or "services”, as contained within section 1 of the VAT Act, deals
with or make specific reference to "dividends”. This matter was resolved
through Decision 329 (taken by the Commissioner of Inland Revenue, 20 September
1991) where it was indicated that dividends in
specie should be treated as the "supply
of goods” for VAT purposes.

However, section 7(1)(a) of the
VAT Act also requires that the supply of the goods should be in the course of
or furtherance of the vendor’s "enterprise”. One of the requirements to qualify
as an "enterprise”, as stipulated in paragraph (a) of the definition in section
1 of the VAT Act, is that the "...goods
or services are supplied...for a consideration...”. In the case of the
supply of a dividend in specie, no
consideration is received by the declaring vendor from the holder of shares.
Therefore, it seems as if section 10(23) of the VAT Act will apply which
determines that: "...where any supply is
made for no consideration the value of the supply will be deemed to be nil.” As a result it seems as if no output VAT will
be levied on the declaration of a dividend in
specie as the value of the supply will
be zero.

It is however questionable whether
this position is correct as Interpretation Note: No. 70 (dated 14 March 2013)
specifically dealing with "Supplies made
for no consideration” is silent on, and makes no reference to, the VAT
treatment of dividend in specie distributions.
It is therefore submitted that the distribution of an asset as a dividend in specie could also fall within the
ambit of section 10(4) of the VAT Act where the parties involved are connected
persons in relation to one another, or even within the scope of section 18(1) which
could be applicable irrespective of whether the parties involved are connected
or not. These two provisions are considered below:

Section
10(4)

Section 10(4) of the VAT Act
determines that where a taxable supply is made between connected
persons for no consideration (as in the case of a the distribution of an asset
as a dividend in specie) and the
recipient is not entitled to claim the full input VAT on such supply made to
him (either because the recipient is not a VAT vendor or is a vendor, but does
not amount to at least 95 per cent
taxable supplies), the value of the consideration will be deemed to be the open
market value of such supply. Thus, where a dividend in specie is distributed by a vendor to its holder of shares who is
not a vendor for no consideration, no output VAT will be levied, unless the
holder of shares is a connected person in which case the open market value of
the dividend in specie will be taxed.

Section
18(1)

Section 18(1) of the VAT Act
requires an output adjustment to be made where goods were originally acquired
for the purpose of the making of taxable supplies (and on which, as a result,
input VAT was allowed at original acquisition) if they are subsequently applied
by that vendor for a purpose other than for the said purpose. For example,
where a vendor acquires an asset to be utilised in
its enterprise for the making of taxable supplies and subsequently decides to
distribute that asset as a dividend in
specie to its holder of shares, it seems as if this would constitute a "change in use” and would require an
output VAT adjustment in order to cancel out the input VAT allowed at the original
acquisition. Section 10(7) of the VAT Act determines that where goods are
deemed by section 18(1) to be supplied by a vendor, it will be deemed to be
made for a consideration in money equal to the open market value of such
supply. Therefore, output VAT would need to be levied by such a vendor distributing
the asset in specie to its holder of
shares on the open market value of such asset. This would be in contrast with
the nil VAT effect under the supply at no consideration in terms of section
10(23) of the VAT Act as discussed above.

Therefore, irrespective of whether
the parties are connected or not, there seems to be a mismatch in the VAT
treatment as the distribution of an asset as a dividend in specie seems to fall
within the scope of both section 10(23) and section 18(1) (read with section
10(7)) of the VAT Act. Neither of these sections mutually excludes one another,
nor does it specify the order in which it should be applied.

It is clear that the VAT effect of
dividends is no simple matter. VAT vendors making distributions of dividends in specie should carefully consider the
circumstances under which these distributions are made, as the incorrect interpretation
could result in unforeseen VAT consequences.

This article first appeared on the July/August 2015 edition on Tax Talk.

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